Skip to main content

Free Banking and the Rationale for Central Banks

If free banking is so great and has worked in the past, why then did central banks develop?  Free bankers answer this question by arguing that central banks generate seignorage revenue for governments, thus central banks exist for a fiscal reason.  Although this may be the case for some developing economies, central banks generate relatively little income in economies with sophisticated tax-raising bureaucracies.
 
The mainstream and dominant view is that central banks exist to stabilise the financial system, which is prone to episodic crises.  Central banks are believed to stabilise the economy by providing liquidity to individual institutions as well as the system as a whole.  As central banks can essentially print money, they are able to create such liquidity almost ex nihilo.  The problem with this view is that historical banking systems were relatively stable even without a central bank.  In addition, the ongoing financial crisis occurred despite (and maybe because of) the existence of sophisticated central banks.

The other explanation as to why central banks (and the gold standard) emerged has been put forward by the late Earl Thompson of UCLA and Charlie Hickson.  Thompson and Hickson suggests that central banks operating under a gold standard were a vital institution which ensured the survivability of democracies.  As democracies are overly appeasing in the face of an external threat, a central bank with a national currency which could expand the money supply in a defensive emergency was necessary for the long-term survivability of democratic nations.  You can read their argument in full by clicking here


   

Popular posts from this blog

Bitcoin Bubble?

According to Robert Shiller , speaking at Davos, Bitcoin is a perfect example of a bubble - story here . Shiller sees Bitcoin as a backwards step in the evolution of money.   George Selgin , a free banker, takes an opposing view - click here .  Although he doesn't believe that Bitcoin is money, he sees its development as a fascinating turn in the evolution of money. In particular, he lauds the fact that Bitcoin production is constrained and cannot be infinite. There is a short video below where Bitcoin explain how it works.

How Valuable Are Connections?

Daron Acemoglu, Simon Johnson, Amir Kermani, James Kwak and Todd Mitton have written a paper on whether firms connected to Timothy Geithner benefited from these connections. They do so by looking at how stocks of these firms reacted to the announcement that he was a nominee for Treasury Secretary in November 2008. They find that there were large abnormal returns for connected firms. Below is the paper's abstract and the full paper is available here . The announcement of Timothy Geithner as nominee for Treasury Secretary in November 2008 produced a cumulative abnormal return for financial firms with which he had a connection. This return was about 6% after the first full day of trading and about 12% after ten trading days. There were subsequently abnormal negative returns for connected firms when news broke that Geithner's confirmation might be derailed by tax issues. Excess returns for connected firms may reflect the perceived impact of relying on the advice of a small ne

Boom and Bust: A Global History of Financial Bubbles

Boom and Bust: A Global History of Financial Bubbles, co-authored with my colleague Will Quinn , is forthcoming in August. It is published by Cambridge University Press and is available for pre-order at Amazon , Barnes and Noble , Waterstones and Cambridge University Press .